9/5/2008: Updated post is now up – The Gift Tax, Student Loans, and How It STILL Doesn’t Apply to Us (or YAY for Unified Credit)
9/4/2008: This post has been edited for accuracy. Another post will be up shortly to clarify this one. I have struckout the inaccurate portions of this post, but will leave the whole thing up for posterity.
A few weeks ago Her wrote about a generous relative who paid off $50,000 of Her’s student loans. Since then we’ve received a few comments about possible tax implications of such a large transfer of money. Admittedly, we didn’t think about it at the time, so we did some research.
Of course the tax that would apply to our situation would be the Gift Tax. To understand the Gift Tax, I turned to the IRS’s FAQ on Gift Taxes.
The IRS definition of a gift is
Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.
One can gift up to the annual exclusion ($12,000 in 2007) to another person without triggering the gift tax. Also, one can gift up to the annual exclusion to multiple people without triggering the gift tax. There’s a whole bunch of rules on exclusions that I’m not going to get into.
What surprised me is that it is the donor who would normally have to pay the tax, but special arrangements could be made so that the donee could pay the tax.
Of note of the Gift Tax are the exceptions, which are as follows:
- Gifts that are not more than the annual exclusion for the calendar year.
- Tuition or medical expenses you pay for someone (the educational and medical exclusions).
- Gifts to your spouse.
- Gifts to a political organization for its use.
Since Her’s relative paid the student loan directly to the institution holding the loan,
all of the money can be transferred tax-free. If Her’s relative cut us a check and then we paid the loan, Her’s relative would have to pay a tax on the very generous gift. It is very important to note the difference. Her’s relative doesn’t even have to report that any money was transferred.
If someone is going to make a payment for your tuition /
student loan that exceeds the annual exclusion, make sure it is paid directly to the loan institution so that no gift tax will be triggered!
Originally, Her wanted the relative to cut us a check and then we would take care of it. We didn’t know about the tax implications at the time. It is a good thing that the relative just paid the loan company directly.
Since she did that, no one has to report anything, and nothing will be taxed. Yay!